Terrorism poses serious threat to U.S., global financial markets

According to Smith Barney's Consulting Group, the July 2005 bombings in London and Egypt have demonstrated that terrorism can still pose a serious threat to life and safety - and to the stability of the United States and global financial markets. Today, I will provide you with some of consulting group's thoughts on how investors are right to take this threat seriously.

The group believes that the relatively calm reaction in the markets to those attacks also show that most investors have learned not to overreact to such events, which often have little lasting impact on economic and financial fundamentals.

It's also a tragedy when innocent people die, and we should never ignore the pain and suffering that terror attacks cause. But sowing panic is also a key terrorist objective - as is damaging the economies of the United States and its allies. By avoiding sudden or irrational financial decisions made in moments of fear, investors can help reduce the disruption that terrorism causes.

Fortunately, that has been the pattern following most attacks - with the significant exception, of course, of 9/11, which did result in significant economic damage, including a week-long halt to U.S. equity trading. Even, then, however, the market's recovery was impressively swift once trading reopened.

Smith Barney's chief U.S. equity strategist, Tobias Levkovich, has looked at stock market behavior following past terror attacks both at home and abroad, and found that the long-term investor reaction - and in many cases the short-term reaction as well - was generally very restrained.

At the same time, though, Levkovich also found that overall risk expectations have risen sharply since the 9/11 attacks - a trend he attributes, at least in part, to concerns about the threat of terrorism.

In his report, "Cataclysm, Terrorism and Stocks," Levkovich argues that the stock market's performance in the wake of past attacks appears to have been largely dominated by other factors, such as the cyclical trend (bullish or bearish) in place before the strike occurred.

"The 9/11 terrorist attacks were not the defining event for ... stock market performance," Levkovich wrote, "Rather, it appears that the event exacerbated the trading range process already underway."

Market reaction to two major pre-9/11 attacks on American soil - the 1995 Oklahoma City bombings and the 1993 World Trade Center bombings - were even milder.

The Dow actually rose following the first two attacks - both of which occurred at times when the economy was growing and investors were expecting corporate earnings to rise sharply. Against this backdrop, it's not surprising that the attacks - while devastating to the individuals and communities directly involved - had relatively little market impact.

The 9/11 attacks, on the other hand, delivered a far more damaging blow to the country. However, it's important to remember that both the economy and the stock market were in a slump even before the attacks happened.

As Levkovich points out, the market's post 9/11 tumble - which took the Dow down over 14 percent in the first week after trading reopened - actually marked the end, not the beginning, of a shorter-term pullback that started earlier in 2001. After hitting a three-year low on Sept. 21, the market then rose into early 2002, when growing concerns about sluggish earnings and corporate accounting scandals caused the rally to falter.

The pattern of trading in the market's post-9/11 slump also largely matched the trends generally seen during that period, Levkovich notes: "Groups that have typically outperformed the broader market in trading ralliesa Materials, Information Technology, Diversified Financials, Capital Goods and Media - beat the S&P 500 while typically rally under-performers like Consumer Staples, Energy and Health Care lagged." His conclusion: "Should another terrorist attack occur within the United States, we would not assume that portfolios should be positioned defensively. Instead, we suggest that a shock to the system could be short-lived and that the fundamentals in place will remain relevant."

If previous terrorist strikes on U.S. soil have had little lasting effect on the stock market, attacks in other countries have had even less. "Terrorist attacks overseas," Levkovich notes, "have done little to rattle equity markets past the first week after their occurrence, even when Americans have been the target of the attacks."

There is, of course, no guarantee future terrorist strikes will be on the same scale as the recent subway bombings in London or the car bomb attacks in Egypt. If a terrorist group were to get its hands on biological or radiological weapons, the damage could be much more severe, even catastrophic.

But the possibility of a truly catastrophic event - like a giant earthquake in California, or a direct hit on a major city by a Category Four hurricane - is a risk investors already face. As Levkovich notes, America has experienced many terrible events in its history, "yet the country has survived these tragedies, and so have its financial markets." For more information, call 689-8704 or e-mail William.a.creekbaum@smithbarney.com.

-- William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of SmithBarney, a financial services firm serving Northern Nevada at 6005 Plumas Street, Ste. 200 Reno, NV 89509.